Will Budget 2020 deliver a pay rise for British workers?

Expectations are high for the upcoming Budget to deliver on a number of ambitious promises – from ‘levelling up’ the UK economy to raising long-term growth and improving public services. After more than a decade of dismal pay growth – real-term earnings have only last month returned to levels last reached in 2008 – British workers may wonder whether the Budget will help improve pay.

Today, NIESR published a new report, commissioned by the Office of Manpower Economics. Using a unique set of data on sectoral earnings and wage settlements, the report sheds light on the interaction between public sector pay, directly under the control of Government, and that found in the rest of the economy.

One fifth of UK employees work in the public sector. The report shows that wages of public sector employees and wages of those working in the private sectors of the economy form a strong long run relationship. In the past, public sector wages set by Government have over time adjusted to wages in the private sector, often within a few years, to maintain this relationship. Updated estimates in Figure 1, constructed using a methodology developed in the report, show that currently public sector wages are around 3 per cent below the level implied by their historical relationship with average wages in the private sectors. This is unsustainable as the Government is now at risk of losing workers to the private sector who will take with them skills it desperately needs to maintain the provision of vital public services. In fact, the report also finds that wage growth can act as an important pull factor to attract labour to flow from other sectors and this holds in particular for the public sector. So that action now may help attract workers from the private sector and meet shortages in certain sectors.

To give an example, the Government’s ambition is to hire 20,000 new police officers and 50,000 nurses. To encourage individuals to join the police force or the NHS, or to motivate current workers to retire later, pay rises will have to be offered in the upcoming Spring Budget, or in sequels of this year’s fiscal trilogy. This is particularly true given widespread labour shortages, especially in professional service sectors.

What about the four fifth of workers employed in private sectors? Our report also highlights the possibility of pay spillovers from the public sector to the private sector. As public sector pay increases, pay in the private sector tends to follow within a few months. In particular, employees in the domestically facing private sector tend to benefit where workers’ bargaining power is low, such as hospitality and wholesale and retail trade.

So, will the Budget deliver a large pay rise that lifts living standards across the country? Unlikely.

A first constraint is set by the yet to be defined fiscal rules and the Government’s ambition to balance day-to-day spending over the course of Parliament. With a public sector pay bill of around £180 billion, closing the public-private sector pay gap of 3 per cent would cost more than £5 billion a year, or a quarter of a percentage point of GDP.

Public sector pay rises will also be monitored closely by the Bank of England, especially if they spill over into the private sector. With output close to potential, there is a risk that higher pay translates into price pressures which would require tighter monetary policy.  Higher wages then may move in line with higher interest rates, leaving the typical family no better off.

Finally, in the long run pay moves in line with productivity. Productivity growth has repeatedly disappointed with the period after 2008 recording the worst productivity performance in 250 years of British economic history. Compared to a temporary increase in pay, lifting productivity growth through higher government spending and investment is undoubtedly the much bigger challenge the Government faces.

Disclaimer: The views in this blog post and in the published report represent those of the authors and not necessarily those of the Office of Manpower Economics.